Will the SAC Case Affect Investor Confidence?

The image of a Wall Street firm engaged in “substantial, pervasive” insider trading, as the government alleged in its action against SAC Capital Advisors on Thursday, is something that could easily feed into the public perception of the financial markets as a place where the average investor has no chance at a fair deal, where all the real profits are drained by insiders, and the public gets merely scraps – plus a management fee.

The government on Thursday accused SAC of insider trading. The firm said it “never encouraged, promoted or tolerated insider trading and takes its compliance and management obligations seriously.” SAC on Friday pleaded not guilty.

“On a case by case basis, I’m not sure that each individual story amounts to much,” Scott Frew, a general partner at the Connecticut hedge-fund Rockingham Capital Partners, told MoneyBeat. “But certainly when assembled, all the names and terms…are like a huge swirling cloud lowering in the distance.”

Insider trading is not as easy to grasp – or prosecute – as an outright theft, and the practice even has its defenders. But one study did attempt to show it can have an impact on the price of stocks. A 2002 study by Indiana University professor Utpal Bhattacharya, which looked at stock markets around the world measured by their relative levels of enforcement against insider trading, indicated that the cost of stocks was generally higher in countries with relatively lax laws and enforcement. Compound that over the life of your 401(k), and you can see how it affects investors.

“It is the enforcement, not the existence of insider trading laws, that matters,” Bhattacharva wrote.

Barofsky told MoneyBeat that previous enforcement efforts – the kinds of “milquetoast” civil enforcement efforts that extracted modest fines and no admissions of guilt – didn’t give people any confidence that the government was policing Wall Street.

The case brought forward by U.S. Attorney Preet Bharara, who Barofsky worked with in the past, was an “incredibly aggressive indictment,” Barofsky said. The government is attempting to show that SAC is effectively a criminal enterprise and is seeking forfeiture of as much as $10 billion it says are ill-gotten gains.

Regardless of whether SAC is found innocent or guilty, Thursday’s announcement, combined with the successful prosecution of Raj Rajaratnam and dozens of others for insider trading, shows the government is attempting to go beyond the levels of enforcement it has brought before, Barofsky said.

“This could send a message that the government is on this,” he said. “It could convince people to come back in.”

These kinds of things happen on Wall Street, and aren’t exactly a secret anymore, said John Bogle, the father of the exchange-traded fund and founder of Vanguard Group. Bogle thinks the case may be damaging to the hedge-fund industry, “the bloom could be even more off the rose” he said, but he doesn’t think it will have a big effect on investor confidence.

“The long-term investor shouldn’t lose sight of the fact that they’re investing for retirement, for the next 30-35 years,” he said. “This case isn’t even going to be a footnote to history, not even a footnote to a footnote.”